Business Context and Reporting Period
Company: CM Finance Inc (CMFN)
Filing Type: Form 10-K (Annual Report)
Period Ended: June 30, 2016
Business Overview: CM Finance is an externally managed, non-diversified closed-end management investment company regulated as a Business Development Company (BDC). It invests primarily in the debt (unitranche, first lien, second lien) and related equity of privately held lower middle-market U.S. companies. The company is managed by CM Investment Partners LLC.
Key Financial Metrics
| Metric | 2016 (Year Ended June 30) | 2015 (Year Ended June 30) |
|---|---|---|
| Total Investment Income | $35.58 million | $36.92 million |
| Net Investment Income | $19.85 million | $20.22 million |
| Net Increase (Decrease) in Net Assets from Operations | $(9.34) million | $15.43 million |
| Net Asset Value (NAV) per Share | $11.90 | $14.41 |
| Total Assets | $319.96 million | $360.46 million |
| Total Liabilities | $157.21 million | $163.51 million |
| Portfolio Fair Value | $272.11 million | $330.32 million |
| Weighted Average Yield on Debt | 9.80% | 10.91% |
| Asset Coverage Ratio | 2.23x | 2.31x |
| Outstanding Debt (Term + Revolving) | $132.48 million | $150.85 million |
Material Changes vs. Prior Period
- Operating Loss: The company reported a net decrease in net assets from operations of $9.34 million in 2016, compared to a net increase of $15.43 million in 2015. This reversal was primarily driven by a net change in unrealized depreciation of $29.48 million.
- Portfolio Valuation: Portfolio fair value declined by approximately $58.2 million (17.6%) year-over-year. Significant unrealized depreciation was recorded for investments in Bird Electric Enterprises, LLC, AAR Intermediate Holdings, LLC, and YRC Worldwide, Inc.
- Asset Quality: As of June 30, 2016, two investments were placed on non-accrual status, representing 6.2% of the portfolio. In the prior year, no investments were on non-accrual. The percentage of the portfolio rated "Investment Rating 5" (expected loss of principal) increased to 6.2% from 0% in 2015.
- Investment Income: Total investment income decreased by $1.34 million, largely due to the non-accrual status of two portfolio companies.
- Debt Reduction: The company reduced its revolving credit facility drawdown from $48.8 million in 2015 to $30.5 million in 2016, while the term loan remained constant at $102.0 million.
Guidance, Outlook, and Risks
- Dividend Policy: The company declared a quarterly distribution of $0.3516 per share for the quarter ended September 30, 2016. The Adviser has agreed to waive incentive fees through December 31, 2016, to support an annualized dividend yield of 9.375% based on the IPO price.
- Liquidity: As of June 30, 2016, the company held $18.4 million in cash and $18.0 million in restricted cash, with approximately $19.5 million of capacity remaining under its revolving credit facility.
- Key Risks:
- Credit Risk: Concentration in the entertainment/leisure (19.5%) and telecommunications (11.0%) sectors exposes the portfolio to industry-specific downturns.
- Valuation Uncertainty: All investments are classified as Level 3 assets, meaning valuations are based on unobservable inputs and management judgment, creating potential volatility in NAV.
- Leverage: The company utilizes a $102 million term facility and a $50 million revolving facility. A decline in asset values could trigger asset coverage ratio violations, restricting further borrowing or distributions.
- Fee Waivers: Current dividend levels are partially supported by fee waivers from the Adviser, which are not guaranteed to continue indefinitely.
Investor Verification Checklist
- Non-Accrual Assets: Verify the specific performance and recovery prospects of the two portfolio companies currently on non-accrual status (representing 6.2% of the portfolio).
- Unrealized Depreciation: Review the specific valuation adjustments made for Bird Electric Enterprises, AAR Intermediate Holdings, and YRC Worldwide to understand the drivers of the $29.5 million unrealized loss.
- Fee Waiver Sustainability: Assess the company's ability to maintain the 9.375% dividend yield without the Adviser's incentive fee waivers in future periods.
- Asset Coverage Ratio: Monitor the 2.23x asset coverage ratio to ensure it remains well above the 2.00x regulatory minimum required to maintain BDC status and make distributions.
- Revolving Facility Expiry: Note that the $50 million revolving credit facility expires in December 2016; verify refinancing plans or repayment strategies.